Sunday, November 30, 2008

The Conservative Party's official stance on the economic downturn is that "It is now vital that we restore stability to the British economy and responsibility to our public finances. Unfortunately, Brown's economic mismanagement means we can’t offer big upfront net tax cuts like some other countries" (party website: http://www.conservatives.com/Policy/Where_we_stand/Economy.aspx). So, no intervention to stimulate demand, except hoping the Bank of England will quickly cut interest rates.

Nobel Prize-winning economist Paul Krugman sees things rather differently: because of the banking system seizing up, interest rate policy has become ineffective and banks won't lend whatever central banks do (we're in a liquidity trap). Here's what Krugman says about the US situation:

"Ben Bernanke can’t push on a string – but he can pull, if necessary. Suppose fiscal policy ends up being too expansionary, so that real GDP “wants” to come in 2 percent above potential. In that case the Fed can tighten a bit, and no harm is done. But if fiscal policy is too contractionary, and real GDP comes in below potential, there’s no potential monetary offset. That means that fiscal policy should take risks in the direction of boldness."

The UK is in a similar position to the US: our banks are not lending, and although the Bank of England base rate still has further to fall, the rates at which banks borrow and lend will remain much higher, diminishing the usefulness of Bank actions. Tried to get a mortgage lately?

So what's left is fiscal policy, and Krugman's powerful point is that it's better to err on the side of recklessness, not caution, because only the former has a fall-back option. If Cameron can come up with a theory as to why fiscal policy can be contractionary without making the situation much worse, than I hope someone nominates him for next year's Nobel.

Saturday, November 29, 2008

Despite a recent OECD report picking out the UK as one of the few countries in which inequality has declined since the year 2000, the most striking thing about the income distribution in the UK is quite how sharply inequality increased after 1980.

In 1979, the Gini coefficient was 0.27, more or less the same as in 1969, and way below the US. By 1986 it had moved up to 0.30 and by 1995 up to 0.34, pretty close to the US (which in the meantime had itself become more unequal). Although there has been a broad upward trend across the advanced economies over the last 2-3 decades, no other western country saw such a sharp transformation.

So, what happened between 1979 and 1995 to make Britain a much more unequal society?

Well, the timing doesn't look good for Mrs Thatcher: she was in the right place (Number 10) and had the motive (a belief in unfettered free markets and individual responsibility) and the tools (monetarist economic policies) to dismantle Britain's post-war welfare settlement. The Conservative governments after 1979 made the tax system more regressive, cut benefit levels for welfare dependents, privatized some public services and passed legislation to weaken trade unions. All these measures could be expected to increase inequality.

So, an open and shut case?

Well, none of this helped of course. But the rapid decline in trade union membership and the resulting decentralization of wage bargaining were caused by something else: the collapse of British manufacturing. Between 1978-83 UK manufacturing output declined by 30%, and 1.5 million manufacturing jobs were lost, a number almost equivalent to the total rise in unemployment in that period. When the economy recovered in the mid-1980s the new jobs created were no longer in manufacturing industry but largely in the service sector, a sector much less unionized, with higher pay disparity and more unstable employment tenure.

This was partly the short-term effect of policy - Thatcher's anti-Keynesian response to a world recession - but partly also a rather abrupt structural adjustment to a changing environment which all western countries were facing. Manufacturing employment declined in the rest of Europe too, and the UK was not the only country to suffer high unemployment in the 1980s.

So does this let Mrs Thatcher off the hook?

Not quite, because other countries in Europe managed this process without an explosive rise in income inequality, usually through various kinds of government intervention. In countries such as France and Italy, subsidized early retirement packages took older industrial workers out of the labour market and into comfortable pensions. In the Nordic countries, the expansion of the public sector into a wider range of social services created new jobs in the service sector with good pay and strong employment rights. And, in countries such as Germany, the 'patient' investment environment and strong trade unions favoured industrial adaptation to changing markets, rather than creative destruction.

All these measures safeguarded equality, but at a cost: government deficits and low employment in France and Italy, punitively high taxes in the Nordics, and a stulted service sector in Germany (leading in part to high unemployment and low growth in the 1990s). So there was no free lunch. In the 1980s, British industry's decline presented us with hard choices. But the choices the Thatcher government made came down particularly hard on unskilled workers and on the industrial regions of the UK.

Sunday, November 23, 2008

David Cameron's new strategy of frontal opposition to Brown's economic salvage plan shows how rattled he is by 'Flash' Gordon's recovery in the opinion polls. It also neatly reflects the debate between Friedmanites and Keynesians which emerged out of the 1970s stagflation and still rumbles on today.

In the 1930s Keynes departed from the classical view of recessions by insisting that government intervention could kick-start the economy by making cash available for consumers to spend. In the 1970s, Friedman objected that this policy was essentially inflationary, and would not achieve the goal of increasing output because market actors would factor in the consequences of this inflation and behave accordingly. So consumers would not be able to consume more and output would not increase, because prices would simply go up in response to the inflationary implications of policy.

A refinement of this argument associated with Robert Lucas held that consumers had 'rational expectations' and would not be fooled by policy. Interest rate cuts would not lure mortgage-holders to spend more, since they would be better off paying down debt in anticipation of future rate hikes to combat the inflation (come to think of it...). Similarly, running a budget deficit (Keynes' automatic stabilizers) would not help either, because consumers would anticipate tax increases in the future to reduce the deficit, and would therefore save more in order to be ready for them. Policy would therefore be ineffective in stimulating demand, increasing inflation for no benefit.

One of the weaknesses of this argument is that its assumption of rational expectations - that market actors use all the available information and knowledge to make guesses about the future, and act accordingly in the present - is perhaps a little heroic. Some people don't read the Financial Times or perform econometric analyses before they go shopping. Others could, but can't be bothered, because they discount the future heavily (live for today). So demand management might work after all, if people aren't smart enough to figure out the consequences of fiscal stimulus packages or interest rate cuts.

So, back to the UK in 2008. Gordon Brown is putting together a fiscal stimulus worth perhaps 30 billion pounds of extra borrowing over the next year, in the hope that we will spend this money to keep Woolworths open and prevent shopworkers, builders, Starbucks baristas and estate agents losing their jobs (I'm particularly concerned about the estate agents). This strategy will only work if consumers go out and spend the money that the government is pumping into the economy. If instead they use the cash to pay down debts or save for a rainy day (isn't today rainy enough already?) then it will all be to no avail.

Here is where David Cameron's helpful intervention comes in. The Conservatives are reviving a campaign poster from 1992 called 'Labour's Tax Bombshell', picturing a bomb wrapped in Xmas wrapping paper. The message states 'Brown's 100 billion borrowing binge will mean higher taxes for you. Don't let him get away with it'.

This translates as 'Brown wants to convince you to go out and spend money to save us from a deep recession, but we would rather you kept the money in your pocket for now, thank you, just like that nice Mr Friedman recommended.'

Saturday, November 22, 2008

British politics is fun again, although life in Britain is getting less funny by the minute for many.

What is fun is the return of real debate about how to run the economy. Although New Labour's similarity to the Conservatives has often been over-stated, the last decade has seen substantial agreeement around the new liberal consensus: sound money (achieved through independent central banks and inflation targeting), balanced government budgets (the 'Golden Rule' keeping national debt below 40%), flexible labour markets (low employment protection, weak unions) and the predominant role of the City of London in generating growth.

What was odd was that although this was natural enough for the Conservatives, it was a real break with tradition for Labour, which had traditionally been more concerned with growth and employment than with price stability, and whose supporters had a lot to gain from union power and entrenched workers' rights. Why did Labour buy into this?

There are two possibilities:

The first is that it was a 'Trojan Horse' inside which the party could smuggle in left-wing policies that middle England and financial markets would take fright at. By committing itself to the orthodoxy, Labour could win over Tory voters and avoid the business sector boycotting a Labour government. In this version, Labour would consolidate itself in government, and then put a more left-wing twist on policy than everybody was expecting.

The second was that they really believed it all.

It matters quite a lot which of these explanations is the right one. Now that the post-Keynesian consensus has run into a brick wall, Labour has a lot to gain from dropping its monetary and fiscal orthodoxy, and beating up on the bankers, a natural target for popular anger. A terrible recession looms, and everyone agrees that for the moment inflation is the least of our worries and government should borrow and spend as fast as the till can open and shut.

Everyone, that is, apart from David Cameron. Cameron has opted for Hooverism as his response to the recession. You wonder if he really believes that the government shouldn't increase borrowing in the middle of a credit crunch - if he does, that would be very scary, since he could one day be running the country. More likely, he figures that government borrowing won't avoid a nasty recession (that's inevitable, all it can achieve is avoiding a full-blown depression) and that in the next election campaign he can blame the government for the recession AND for the country's rapidly deteriorating budgetary position. "See, Brown mortgaged the country's future and we still had a recession!"

So, maybe it doesn't matter for the policy response, which will be Keynesian whatever Cameron says. But it would be a pity if it meant that the common sense notion that you 'tighten your belt' when times are hard is given a serious hearing. If the government tightens its belt when the consumers are tightening theirs, then we are all up a creek without an oar: if the government borrows, than we have at least one.

Wednesday, November 19, 2008

The latest MORI poll makes extraordinary reading. After a year spent on the back foot, Gordon Brown's high profile response to the financial crisis seems to have paid off in a way almost no-one would have predicted. The poll puts the Conservatives on 40% (down 5%) Labour on 37% (up 7), and the Lib Dems on 12% (down 2). This after the Tories enjoyed a wopping 28% lead on September 14th this year (the day before the Lehman Bros collapse) (see http://ukpollingreport.co.uk/blog/ for further details).

What on earth is going on?

Well, a couple of things.First, Brown has been widely praised for decisive action in the midst of the most frightening week or two of the financial crisis, and British voters seem to see him as a serious politician for serious times. His flaws - obsessed with arcane details of policy, lack of charisma, inability to connect with ordinary folk - suddenly appear strengths.Still, surely Brown got us into this mess in the first place, allowing bankers to run riot pumping credit into the market at same the time as allowing government borrowing to grow almost as fast?Well, voters are less worried about who is to blame than about securing their livelihoods, and whatever his past sins Brown is the man at the helm. His opponents - Cameron and the increasingly fragile Osborne - appear young, callow and lacking in gravitas and experience. When you're looking into the abyss, you go for the devil you know...Worse than this, the Conservatives can legitimately criticize Brown's fiscal policy (too much spending and borrowing), but when it comes to private sector excess - which is the real reason this crisis is so serious - they have almost nothing to say, having been opposed to even Labour's minimalistic regulation of the financial sector.

Labour may have been too beholden to financial interests for its own good, but the Conservatives are the party of the City, and cannot easily exploit popular disgust at the catastrophic mess made by the bankers. Labour could still blow it, but the next election will be a real contest.

Inexperienced observers of the British political scene could be forgiven for feeling confused about the nature of political debate here after the last few days of bickering between the Labour government and the Conservative opposition.

First, David Cameron used Prime Minister's question time to express his outrage at the performance of Haringey Council's child protection service, after a baby was brutally killed by its carers after months of abuse. Gordon Brown responded that it was out of order to turn such a tragedy into a party political issue; Cameron responded that Brown's response was 'cheap'.

Second, George Osborne the Shadow Chancellor suggested the possibility of a run on the pound (already about 25% weaker against the dollar than just a few months back). Labour outcry: he could provoke a run with his remarks, how outrageous to put partisan advantage before the national interest in a crisis!

So, do we have a majoritarian democracy or don't we? In the face of an unprecedented economic crisis, Brown has every interest to call for a suspension of normal rules so that the Conservatives cannot make political capital out of the mess; the Tories in turn need to make hay while the sun shines (in partisan terms of course; it's hailstones for the economy). Here, what we could do with is a real debate about the reasons for the crisis and where the policies responsible came from, and neither of the two main parties can avoid blame: who can remember George Osborne advocating restrictions on bank lending in the middle of the boom? Instead what we get is a demagogic fist-fight which leaves most people puzzled. That's the downside of majoritarianism: political competition does not logically lead to enlightenment.

In the Baby P case, the Tories are in a weaker position. The brutal murder of a child by its own family members cannot realistically be blamed on Gordon Brown, just because Haringey has a Labour council. Worse, Cameron claims that many warnings were ignored in the Baby P case, and suggests that social workers are to blame for the tragic outcome. But isn't this the same Cameron who rails against the 'nanny state', and complains incessantly about government inteference in people's private lives? Or does this just apply to the private lives of poor people in desolate inner city estates?

My mind drifts to another desperately upsetting case of infanticide that took place last year, but which did not provoke questions in the House. Alberto Izaga, head of Swiss Re insurance conglomerate's London office, brutally murdered his two-year old daughter, in the middle of what appeared to be a major psychotic episode. He was quickly interned in a secure psychiatric unit, and the tragedy - so difficult to fit into our standard narratives of dangers to children - immediately disappeared from public consciousness. No questions, no demands for accountability. Just a human tragedy we could do nothing about.

Saturday, November 15, 2008

The whole world seems to be celebrating Obama's victory, and even Iran's President Ahmadinejad sent a message of congratulations. Just two world leaders don't seem to have figured out the significance of the event: Silvio Berlusconi and Dmitry Medvedev (the dauphin of Berlusconi's old mate Vladimir Putin). At least Medvedev seems to be hastily backtracking from his sabre-rattling, whereas Berlusconi is still insisting that it was a harmless joke to describe Obama as 'sun-tanned'.The only consolation regarding Berlusconi's gaffe is that its 1970s-style paternalistic racism demonstrates to the whole world what years of cosmetic surgery and hair transplants have been trying desperately to hide: that Silvio Berlusconi is an old man. Just like the defeated John McCain, in fact. Life expectancy for rich westerners may be well over 80 these days, but being 72 all but disqualifies someone from high political office in my view.This is not just because it usually means that you grew up in a world where the west was white and black meant poor and uneducated; in the end someone with the right moral fibre can make the effort to understand today's multicultural reality.Far more serious is that we're entitled to doubt what stake a 72 year old politician has in the world 20, 30, 40 years from now. Can a 72 year old really be expected to tackle climate change and understand what the emergence of new powers such as China and India really means?

I guess Berlusconi knows this, which is why he let slip his bitter, barely sub-conscious, envy towards a man who doesn't need to pretend he's 20 years younger.

Wednesday, November 12, 2008

Rahm Emanuel, Obama's newly appointed White House chief of staff, candidly said the other day that a crisis was a great opportunity that shouldn't go to waste. Sounds cynical, and probably a risky thing to say in public. But the point is that big transformations often come out of terrible crises - in many respects the post-WWII Keynesian welfare state, which delivered unprecedented and almost universal growth in living standards in western societies, probably wouldn't have been possible without the tragedy of the war. In crises, old conventional wisdom loses its legitimacy and new ideas get the benefit of the doubt (Yes we can....!).So will we get any of this here in the UK? Some chance. Labour has been in power for too long to be a transformational force, and bears too much responsibility for our version of the crisis (allowing over-leveraging of households, letting the banks take on too much risk). But the Conservatives are just as trapped in the 'old' discourse - after all, 'prudence' was Brown's way of heading off Conservative scaremongering about Labour's ability to manage the economy without causing inflation and instability. And, lest we forget, the City of London is still instinctively Tory, rather than New Labour. So it's hard to see who can provide the push to get some real change out of this mess. Maybe our only hope is that Brown himself realizes that he over-compensated on neoliberalism and can only save himself by lurching back to a populist left discourse, a la Obama. I'm not optimistic, but...

The current debate over how to rescue the UK economy is a nice touchstone for the state of economic thinking in the main political parties. The Conservatives are talking about tax breaks for small companies to let them keep their staff employed, Labour will allow the deficit to grow (as it already was doing) to provide fiscal stimulus. Is Keynes still alive and kicking?

Well yesterday the government criticized the Tory plan for being 'unfunded', a charge the Tories denied. So we are still not that happy about coming out of the closet on Keynesian methods of dealing with downturns - nobody wants to admit that openly that it involves increasing government borrowing on a big scale. Why not, if that's what economic theory advises? Because it goes against the grain of the 'fiscal responsibility' discourse that Labour adopted 15 years ago to head off charges that they would mess up the economy. If you spend a decade talking about 'prudence', it then hurts your credibility if you say we have to borrow our way out of a recession. A second reason, of course, is that most people have no understanding of the logic of Keynesian fiscal and monetary stimulus, and simply regard it as yet another example of our love affair with debt. Which of course it would be, if we allowed it to run on through the next upswing as well.

So in the end, we will allow the automatic stabilizers to work by maintaining current spending and tax levels, Labour will probably pretend it's being prudent, and the Conservatives will condemn them for being irresponsible and burdening future generations with debt. What Labour really should do instead is cut taxes for the lowest paid (they will spend the money, not save it) and use the opportunity to redistribute some wealth from rich to poor. It will help the economy and help them politically. However, it does risk losing middle England votes, and that's why it probably won't happen.

Friday, November 7, 2008

One aspect I didn't mention about the Meltzer/Richard problem and voters' awkward propensity to vote for the representatives of wealthy interests: campaign finance. Voters only get the chance to vote for redistribution if major parties are offering it. But in this post-mass party age, the best way for parties to run well-financed campaigns is to sollicit donations from well-heeled backers in exchange for policy favours. So, what was George Osborne (or for that matter Peter Mandelson) doing ont he Russian billionaires' yacht? Such a donor can make a decisive influence to a parties' resources, so the temptation to offer private favors (of course, at the collective expense in one way or another) to get the money is unbearable.Obama presumably did some of this too, but he also mobilized large numbers of small contributions, decreasing his dependency on the rich. In the same way, the British Trade Unions' political levy used to provide Labour with money in exchange for delivering benefits to unions. Unions may be 'special interests' in a sense, but if they're representative enough they can come close to representing collective interests in some form.However, Obama's strategy is probably not easy to sustain over time - what happens when the progressive base is disillusioned by all the concessions he will inevitably make?

Wednesday, November 5, 2008

Bit of a shame about the title which suggests a partisan tract, when in fact it is a thoughtful piece of analysis about the relationship between economic inequality and democratic politics in the US over the last half-century or so.

The key thing to take away from this book is its analysis of how US politicians - mainly Republican ones - have got away with following redistributive policies which ultimately favour such a tiny minority of already privileged people. In a democracy, the poor outnumber the rich, so parties proposing redistribution in the other direction should win more votes, and the more unequal the distribution of income, the more voters would benefit from redistribution (Meltzer and Richard (1981) provide a formal model demonstrating this logic).

Except that very often it doesn't work out that way, and particularly in the US, where income inequality is much higher than in most of the rest of the advanced economies. Why?

Krugman dismisses the 'guns and religion' argument (espoused by Obama in an unguarded moment about rural Pennsylvania) and instead focuses on race - the white working class in the South vote Republican, even though they will lose out economically, because the Republicans will defend them from the threat of 'black power' and maintain their relative advantage viz African Americans.

Two points on this:

First, if he's right, than Obama's election should be a step towards that coalition breaking down (Krugman argues it already is collapsing).

Second, this argument may work for the US, but what about European countries, such as the UK and Italy, where inequality has grown fast in the same period, but there is no significant race issue on which to mobilize white voters to support anti-redistribution policies?

First, electoral stability can be misleading. We've got used to Americans not turning out to vote, and 'Red' and 'Blue' states remaining solid, with just a couple of 'battleground' states deciding the result of the election. Trouble is, every now and again there are big shifts in electoral support - Obama has taken Florida and Ohio comfortably, and even Virginia by a comfortable margin. Possibly North Carolina too. Now this may be a blip, but it fits with Paul Krugman's claim in 'The Conscience of a Liberal' that a clear trend towards Democratic dominance has emerged over the last decade or so, relating to demographic change, registration of new immigrant votes, and the decline of race as a polarizing issue in an increasingly non-WASP America. This election has probably consacrated that shift, entrenching the Dems in power for a generation. Maybe. The point is that electoral change may be glacial but becomes visible rather abruptly (partly because our empirical observations are few and far apart - when is a trend a trend rather than a blip?).

The second point is that unequal societies eventually generate a reaction against unfair politics and institutions. The US (like the UK) has presided over a vast increase in inequality over the last 30 years, which has been accepted in part because of a lack of clear alternatives to free market ideology, and in part because of a failure to mobilize the losers from this process. In 2007-8, both these reasons have lapsed. The free market binge has created an economic disaster that even neoliberals can't bring themselves to deny, and Obama's campaign has used the energy of a new generation of voters and new fund-raising technology to mobilize the disenfranchised. The key here is mobilization - Obama has a broad base, and is less beholden to special interests than, say, Clinton. This, and his skin colour, are strong reasons for marginalized social groups to be convinced that voting is not a total waste of time. In other words, the progressive movement must mobilize the base, and truly progressive politics cannot work if you have to make pacts with monied interests. That is the limit of the New Labour strategy - let's see if Brown learns the lesson.